Buffer gives cause for concerns

3 November 2014 17:20

(updated: 21 March 2016 17:21)

Buffer gives cause for concerns

Finn E. Kydland believes that a predictable financial policy rather than monetary policy is crucial to improving productivity in the eurozone: "To me, a capital buffer seems unnecessary", he says.

"I think financial policies are much more important than monetary policies. That's what we have seen in other countries, and I expect that to be the case in Norway as well. I am unconvinced that the capital buffer is an especially necessary measure", notes Finn E. Kydland.

Bank problems blown out of proportion

According to Norges Bank, the purpose of the countercyclical capital buffer is to make banks more resilient to loan losses. The intention is to reduce the risk that banks will reduce the granting of credit in a recession.

The Nobel Laureate from 2004 is a Professor in the Department of Economics at UC Santa Barbara and an honorary doctor at NHH. In the mid-seventies, Kydland was an Assistant Professor at NHH.

Kydland thinks the significance of the banking problems in the United States has been inflated somewhat, and that the decline was driven more by investments. According to Kydland, the primary reason is the insecurity linked to future financial policies, not future monetary policies.

Amassing national debt

"Already before this financial crisis, there were studies showing that the American taxes likely needed to be increased by four to five percentage points, otherwise the budget would collapse. Thereafter, the financial crisis in itself led to a large amassing of national debt. Companies are probably worried that the tax increase is likely to mainly fall on them. Time inconsistency insights indicate that this is most likely", he thinks.

He does not believe the potential for detailed management is there, and furthermore public authorities are not very good at managing the banks in detail.

"The most important thing is for banks to finance innovative activities, for example entrepreneurs. If a side effect of this type of detailed management is that innovative activities are negatively impacted, this would not be very good", he points out.

Problematic productivity

Kydland looks to other European countries to find examples of failed financial policies.

"They blame the Euro to explain their problems, and that is just silly. The main problem in the eurozone is that the productivity in countries like Italy, Spain and Portugal declined to zero in the early 1990s, and has been at zero for twenty years. That was long before the Euro crisis. The first thing I would look into, is whether anti-competitive regulations were introduced in these countries, and whether this led to the shutdown of productivity growth.

Kydland believes that it can be dangerous to introduce rules that make it more difficult for entrepreneurs who create productivity to engage in their activities.

"For example, it has become much more difficult for small and mid-size companies in Spain to get loans. To the extent that for instance a capital buffer can have such an effect, it gives cause for concern", Kydland notes.

Ireland managed well

Ireland is a good example, according to Kydland. He believes Ireland did its best to get rid of the uncertainties around its financial policies in the early 1990s by guaranteeing the same tax rate for many years to come for companies that chose to start up.

Kydland thinks that it is precisely a predictable financial policy - rather than a monetary policy - that is crucial to improving productivity in the Eurozone.

"In contrast to Spain and Portugal, Ireland is one of the countries that has managed well since 1990. Though things have slowed down in Ireland, productivity remains high, at about 40 to 50 per cent higher than in the other three countries. If Italy, Portugal and Spain cannot figure out how to increase productivity, they will have problems for a long time to come."

This article was first published in NHH Bulletin nr. 3/2014, in Norwegian.

Read more about Finn Kyland

Text: Ellen Balke Hveem